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3 Reasons Emerson Electric Company's Stock Could Rise

The bullish case for Emerson Electric Company's stock.

Having endured a difficult 2014 so far, industrial equipment manufacturer Emerson Electric Co.(NYSE:EMR) is hoping to close out its year on a stronger note. By management's own admission, growth hasn't been as strong as it had expected it to be, and the company is trending toward the bottom end of its forecast for 3%-5% underlying sales growth for the full year. With that said, there are three key catalysts that could drive the stock higher from here. It's time to look at them in more detail.

Emerson Electric Co. is primed for growth

Firstly, this article is part of a series of articles on the company, and readers can learn about what management wants you to know in this article. One of the factors highlighted in the linked article leads into the first upside catalyst for Emerson Electric. Simply put, the company finds itself in the unusual position whereby orders are growing faster than sales, creating a significant backlog. For example, the three-month average for orders came in with a 7% increase at the end of July, whereas underlying sales growth was only 3% in the third quarter ended in June.

The result of the order build-up -- while customers remain in cautious mode with their current spending -- has been to push the backlog up 20% on a year-to-date basis. In fact, Emerson Electric's backlog is now at record levels. This creates a potentially positive scenario for Emerson Electric, because if customer sentiment shifts in the near future -- and management blames the geopolitical environment for much of the negativity -- then Emerson is primed to see a good acceleration in near-term sales as the backlog gets reduced.

Moreover, management is doing all of the right things to position Emerson Electric for growth. On the third-quarter conference call, CEO David Farr argued that "profitability remains at record levels." Indeed, gross margin improved by 130 basis points to 41.8%, and earnings before interest and taxes, or EBIT, margin improved by 90 basis points to 17.7% in the third quarter.

Furthermore, cash conversion remains excellent, with 96% of net earnings converted to free cash flow in the first nine months, compared with 102% (adjusted for goodwill impairment) for last year. In fact, operating cash flow is now expected to come in at $3.5 billion for the full year, a figure higher than previous expectations. The company is primed for growth.

Orders are trending higher

Orders are good, and they are also trending better. This is an indication that there was some sort of temporary slowdown in the spring, as a consequence of customers digesting geopolitical events such as Russian peoples/Ukraine conflict, and turmoil in the Middle East. However, if the order trends from July are a good indication, then conditions may well get better.

The following table shows the three-month order averages for each of Emerson Electric's business segments. Readers can see that there is somewhat of an order deceleration in May and June, but orders appear to pick up in July.

Segment

March (%)

April (%)

May (%)

June (%)

July (%)

Process Management

10-15

10-15

15

5-10

10-15

Industrial Automation

5-10

5-10

5

5

5-10

Network Power

5-10

5-10

5-10

0-5

5-10

Climate Technologies

0-5

5-10

5

0-5

5-10

Commercial & Residential Solutions

5

0-5

0-5

0-5

5

Total

5-10

5-10

5-10

5

5-10

Source: Emerson Electric Co. presentations.

Interestingly, fellow industrial conglomerate Danaher Corporation(NYSE:DHR) also reported a bit of weakness in June; readers can follow the company in a series of articles linked from here.

Restructuring activities

While the macro environment remains beyond control, management has been busy restructuring the business in order to generate margin improvements. Two events stand out. First, the divestiture of Artesyn (network power segment) saw a reduction in sales and EBIT of 20% and 12%, respectively, in the third quarter. However, EBIT margin in the network power segment increased by 60 basis points to 8.7% in the quarter, and Farr expects the full-year margin figure to come in between 9%-9.2% and then improving to more than 10% in 2015. Even though the full-year figure for network power margin is lower than some estimates, it still represents an increase and, therefore, the company's commitment to increasing profitability.

Second, the company has announced plans to evaluate strategic alternatives for its power transmission solutions business (industrial automation segment) and, according to reports, is preparing to try to sell the business for around $1 billion. Again, this kind of initiative demonstrates how management is restructuring the business.

The takeaway

All told, Emerson Electric Co. is clearly in a position to take advantage of any growth out there, and there are some early indications that its order trends are improving. The restructuring activities and planned divestitures are helping to increase margins and returns to shareholders. Meanwhile, management's commitment to engage in buybacks and dividend increases for shareholders should support the share price. The company may yet have a strong year in 2014.

Author

Industrial sector focus. A firm believer in behavioural finance and an Austrian approach to the business cycle. Follow me on Twitter to receive quick and thorough analysis of your favorite stocks.
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